Pakistan has to remain in IMF program and impose more taxes but with equity
It has only been a few months since the Pakistani government revived the stalled IMF Extended Fund Facility (EFF) program. Its resumption made it possible for the Asian Development Bank to disburse $1.5 billion as emergency funding for flood relief. In order to continue with the EFF program, the Government of Pakistan with the Fund mission needs to successfully conclude the 9th review so that the next IMF tranche is disbursed. While discussions with the IMF are ongoing, a timeline for the formal review mission has not yet been announced, at a time when Pakistan faces significant macroeconomic challenges. Finance Minister, Ishaq Dar’s, much too frequent assurances that the government remains committed to completing the IMF program remind us of the line from Hamlet, “The lady doth protest too much, methinks.” Actions rather than declarations would be more convincing.
Before the 9th review process formally begins, the Fund, as per usual practice, is likely to have requested realistic revenues and expenditure estimates that take into consideration the impact of the devastating floods on the government’s fiscal projections. A comprehensive backward-forward-looking approach that incorporates reprioritization of existing allocations for flood relief and rehabilitation, as well as additional revenue measures for the correction of fiscal and/or external slippages seems to be the way forward. However, in the period leading up to elections in the coming year, the government may be reluctant to announce a mini-budget where more taxes are imposed on a public that is already suffering from high inflation and low economic growth. Instead, it would want the lender to offer concessions because of the extenuating circumstances arising from the devastating floods. These expectations may be unrealistic given Pakistan’s debt position and tight financing means.
Public resentment against the inequity of the system in Pakistan is rising and policymakers must take note.
As the 9th review talks are ongoing, markets remain unsettled, which has contributed to a sharp spike in Pakistan’s credit default swap (CDS) pricing. The Pakistan Eurobond and CDS pricing effectively shut out Pakistan from international credit markets. The nervousness of the markets may be justified by the fact that foreign exchange reserves are now below $8 billion. Although Pakistan is unlikely to default on its upcoming payment of $1.05 billion against the maturity of Sukuk on December 5th, it could face a balance of payments crisis in the new year if it fails to: exercise fiscal restraint, tackle existing restrictions on forex flows, and secure inflows of foreign exchange from multilateral agencies and friendly countries. Failure to conclude the review is likely to put the country on a path of default, which would be most disruptive to the welfare of Pakistanis. On the other hand, the successful conclusion of the 9th review would help reduce the chances of such an event occurring. The release of the next IMF tranche would not only bolster reserves but also help open up the inflow of forex from other sources.
The government, therefore, should have a realistic plan that helps in the steady progress of the review by delineating additional revenue sources to bridge potential shortfalls arising from expanded expenditures as a result of the floods, and less tax generation due to the economic slowdown. Imposing additional customs import duties may be already under consideration but given that the revenue shortfall could range from PKR 400 billion to as much as PKR 600 billion, the revenue enhancement measures will have to go further. Among these, the imposition of up to 17 percent general sales tax on petroleum products over and above the PKR 50-per-liter levy already being implemented, as a source of additional revenue to the tune of PKR 200-400 billion could be explored. The government could also increase corporate taxes. The imposition of indirect taxes will fuel another round of inflation to further squeeze the spending power of the middle class while the corporate taxes will deter investment and job creation.
Once again, the burden of additional tax revenue generation measures will predominantly fall on already heavily taxed segments of society. The latest round of taxes may be unavoidable given the exigencies of Pakistan’s fiscal constraints, but policymakers need to learn from history. The taxation system of Ancien Régime was scorned for being “excessive, inefficient and unfair” and contributed considerably to the fiery impetus for the French Revolution. The unfairness of the system meant that the bulk of direct taxes was levied on the common people, while the clergy and the nobility paid little or no taxes. Similarly, there is a growing sense of grievance among middle-class Pakistanis that they have to bear a disproportionate burden of generating tax revenues. Patience is running short with the overall structure where the retail, agriculture, and real estate sectors are left outside the tax net. Public resentment against the inequity of the system in Pakistan is rising and policymakers must take note of that when imposing new taxes.
— Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.